Roth IRA 5 Year Rule

[Aussie]

I did a Roth 401K rollover to Roth IRA this year in 2025. This will be the 1st year for the Roth IRA.

I am over 591/2 years of age so I meet that requirement.

Future distributions taken before Jan 1, 2030, will not be qualified due to the 5 year rule.

Please help me understand how the pro-rata rule and 5 year rule will come into play if I decided to take an unqualified distribution before the 5 year period is up. I have read so many conflicting information in my research. Also how does the source hierarchy affect any tax implications?

If I make bad investments and incur losses to the point my Roth IRA current market is less than original rollover amount, does that have any bearing on an unqualified distribution?

What is the pro-rata based on and does it change over time based on losses or increases?

[Opus 17]

There are 2 5-year rules.

The general 5 year rule says that earnings you withdraw are subject to regular income tax unless the account has been open 5 years.  That means a Roth IRA.  A Roth 401K doesn't count.  The clock doesn't start when you opened this IRA account (maybe), the clock starts when you opened your first Roth IRA account, even if it was a different account years ago.  If you never had any Roth IRA anywhere, then you are correct that your withdrawals are not qualified until 2030 and if you withdraw earnings before then, you will be subject to regular income tax.  (There is no 10% penalty for early withdrawal since you are over age 59-1/2.)

There is another 5 year clock that applies specifically to Roth conversions -- converting pre-tax funds in a traditional IRA or pre-tax 401k to a Roth IRA.  Since you did not do that, I won't discuss that rule further for now.

I don't know what pro-rata rule you mean.  That would apply if you had pre-tax and after-tax contributions mixed in a traditional IRA.  If you had a Roth 401k, that money should all be after-tax, and a Roth IRA is all after-tax.  Roth withdrawals are always counted as contributions first, rollovers second, and earnings last.  Withdrawal of contributions and rollovers is tax free.  Withdrawal of earnings is tax free if your Roth was open more than 5 year and taxable if less than 5 years.  Suppose your rollover amount was $100,000.  That means the first $100,000 you withdraw would be tax free.  If you withdrew more than that (earnings), and it was less than 5 years, the withdrawal would be taxable.

[Aussie]

Thanks for your reply and it mostly makes sense. What I need to clarify is how the contribution amount is determined.  This is my first Roth IRA. I retired in 2024 and had very little earnings for the year and small 401K contribution. My 1st Roth 401K contribution year was 2010 and 1st year of withdrawal without penalty was 2015. My last contribution made was in 2024 as little as it was. Fidelity (my 401K broker) tells me when the rollover took place the rolled over amount would include contribution + earnings (all Roth $$). Using the $100K example, Fidelity is telling me my contributions are $49,000 and earnings are $51,000 and that the Pro-Rata rule would come into play if I take an unqualified distribution (less than 5 years) from Roth IRA. I am not mixing source funding, all is 100% Roth.

From what you were saying, its sounds like the full amount of rollover ($100K) would be treated as 100% contribution and there would be $0 earnings. If that is the case, then growth in the Roth IRA would be earnings ($50K if market value of the Roth IRA is $150K at the time of distribution).  Is that correct?

If so, what do you make of Fidelity telling me the rollover would come across as both contribution & earnings into the Roth IRA? And what Fidelity says about the Pro-Rata rule?

Thank you.

[Opus 17]

@Aussie 

There is probably a special rule regarding rolling over a Roth 401k to a Roth IRA.  A better expert on this board is @dmertz ; they can explain whatever I have forgotten or gotten wrong.  

Now there is a different pro rata rule that I do know a little about.  If you have pre-tax money and after-tax money mixed in a single 401k account, when you roll that over, the custodian is supposed to put the pre-tax money in a traditional IRA and the after-tax money into a Roth IRA. But you said you had a Roth 401k account.  So unless I am missing something in your explanation, this second situation does not apply to you.  

Going back to the rollover of a Roth 401k to a Roth IRA, this article says the money keeps its character -- your workplace contributions go into the contributions bucket in your IRA, and the earnings go into the earnings bucket.

https://irahelp.com/roth-401k-to-a-roth-ira-rollover-how-does-this-work/

Assuming that is true, you need to add up your contributions over the years and subtract your withdrawals that you said you have already made (since withdrawals come from contributions first).  That number might or might not come out the same as Fidelity calculated (I would try and calculate it independently to see if you match their results).  If it is the case that, out of $100,000 rolled over, $49,000 is in the contributions bucket, then the first $49,000 you withdraw counts as contributions and is tax-free, and if you withdraw more, that counts as earnings and is subject to tax if it is before 2030.  

My thought that the entire amount counts as a rollover or conversion is apparently wrong.  But best to wait for @dmertz. 

[dmertz]

If the distribution from the Roth 401(k) would have been considered to be an entirely nontaxable qualified distribution (Roth 401(k) 5-year period met and over age 59½) if paid to you instead of being rolled over to the Roth IRA, the entire amount rolled over to the Roth IRA became contribution basis in the Roth IRA.  Otherwise, your basis in the Roth 401(k) became corresponding basis in the Roth IRA.

Distributions from a Roth IRA are not pro rata.  They follow Roth IRA ordering rules.

[Aussie]

@dmertz

In my case, if I were to take a distribution from my Roth 401K, it would be considered a qualified distribution as I do meet the qualified distribution requirements for the Roth 401K (over 591/2 old and Roth 401K account is 15 years old), however a distribution from my Roth 401K has never been made.

I need to clarify a few things from your previous response. 

I just opened my first Roth IRA and so 2025 is first of 5 years going forward with the Roth IRA.

So far I have only rolled over a portion of my Roth 401K to Roth IRA. For discussion purposes, lets say the total value of my 401K prior to the rollover was $300K of which $140K was reflected as contributions while I was employed ($$ I contributed from my monthly paychecks) and $160K was considered earnings (amount my account grew on top of my direct contributions).  The ratio of contributions to earnings would be 47% contributions / 53% earnings.

Of the $300K balance in Roth 401K, I rolled over $200K

Fidelity is telling me the $200K rollover is a non-taxable event, however none of the $200K is considered a contribution to the new Roth IRA as it is considered a rollover and not a contribution and the basis of the Roth 401K will become the basis for the Roth IRA. Therefore the ratio of contributions to earnings (47%/53% respectively) will apply to the $200K of rolled over funds. This would calculate to $94K being treated as contribution and $106K treated as earnings (not to confuse with the entire $200K rollover is non-taxable event).  This ratio split would only come into play if I take a distribution prior to the 5 year period.

If I understood you correctly, I thought you were previously saying if the funds in my Roth 401K could be considered a qualified distribution (if I had taken one), then 100% of the funds rolled over to the new Roth IRA would be treated as a contribution to the Roth IRA with no earning attached. If I understood this correctly, then any growth above & beyond the $200K would be considered earnings and this would come into play should I take an unqualified distribution from the Roth IRA before the 5 year period is up. 

So what I need to confirm/clarify is if I were to take $125K unqualified distribution from the new Roth IRA before 2030, would there be any taxable implications based on the ordering rules (contributions 1st, earnings 2nd)?

Again, the Roth 401k is older than 5 years and I'm older than 591/2 years and no distribution was made from the Roth 401K, only rolled over to Roth IRA.

What is the determining factors for the basis of Roth 401K becoming the basis for Roth IRA rollover?

Thank you in advance for your clarifications1

[dmertz · Accepted solution]

Your rollover from the Roth 401(k) to the Roth IRA was a distribution from the Roth 401(k), and was a qualified distribution because you were over age 59½ and had met the 5-year qualification period in the Roth 401(k).  It was just not a distribution paid to you personally.

Because you had met the qualification requirements for the Roth 401(k), the entire amount rolled over from the Roth 401(k) to the Roth IRA became contribution basis in the Roth IRA.  The ratio of contributions to earnings in the Roth 401(k) is entirely irrelevant because your Roth 401(k) is qualified.

With $200k rolled over from your Roth 401(k) to your Roth IRA, you can distribute up to $200k from your Roth IRA without dipping into any amount that would be earnings in the Roth IRA.

"What is the determining factors for the basis of Roth 401K becoming the basis for Roth IRA rollover?"

The determining factor is whether or not your Roth 401(k) was qualified at the time of the distribution and rollover.  See CFR 1.408A-10 Q&A-3 which includes, "Thus, the entire amount of any qualified distribution from a designated Roth account that is rolled over into a Roth IRA is treated as a regular contribution to the Roth IRA."  https://www.law.cornell.edu/cfr/text/26/1.408A-10

[Opus 17]

[removed]

[Aussie]

@dmertz

Thank you for the clarifications. The information you sent makes sense.

From what I have learned is anytime there is a rollover from a "Qualified" Roth 401K to Roth IRA, the entire rollover amount is now considered the new basis in the Roth IRA account. Any growth of this basis amount within the Roth IRA would be considered earnings prior to the end of the 5 year period.

Also a direct rollover from Roth 401K to Roth IRA (trustee-trustee) is considered a "distributed rollover".

Where I was getting hung up with Fidelity is they kept saying my rollover was not considered distributed but rather just rolled over into the Roth IRA. Terminology seems to be the culprit here. They also said the contributions & earnings within the Roth 401K would be transferred as well but it appears this should only apply if the funds in the Roth 401K were considered non-qualified which is not the case for me. 

My last question for you is regarding the 1099-R I should be getting for this rollover in January (according to Fidelity).  Is there anything on Form 1099-R I should be concerned about with regards to how it may or may not affect the "Basis" amount for the initial Roth IRA rollover? For example, I see boxes 5 and 9b that address employee contributions. If these boxes reflect my contribution amount as shown in my Roth 401K, will that affect how the IRS treats the whole rolled over amount as contribution basis?

Or does the 1099-R have no bearing on how the entire rolled over amount is treated?

Again, Fidelity is tripping me up by saying since I am not getting a check (following the 60 day rule), the rollover is not considered a distribution and the fact my Roth 401K is qualified does not seem to matter.

Fidelity also says the rollover cannot be considered a contribution to the Roth IRA as if it was, then contribution limits would apply. 

[dmertz · Accepted solution]

"Where I was getting hung up with Fidelity is they kept saying my rollover was not considered distributed but rather just rolled over into the Roth IRA. Terminology seems to be the culprit here. They also said the contributions & earnings within the Roth 401K would be transferred as well but it appears this should only apply if the funds in the Roth 401K were considered non-qualified which is not the case for me."

What they were likely saying is that the funds were not distributed to you.  It's still a reportable distribution from the Roth 401(k) and a rollover to the Roth IRA.  You can't have a rollover without a corresponding distribution.  The distribution from the Roth 401(k) indeed consisted of a pro rata mix of contributions and earnings, but the distinction is moot because the distribution from the Roth 401(k) was a qualified distribution.

I'm not sure what amount will appear in box 5 of the Form 1099-R but I suspect that it will only show the portion that was contributions, not the entire box 1 amount.  If that's the case, you'll have to adjust your Roth IRA contribution basis in TurboTax because TurboTax only uses the amount in box 5 of a code-H Form 1099-R as the automatic addition to basis.  However, in your case the entire amount rolled over became basis.  You would make this adjustment by adding to your cumulative basis for prior years the difference between box 1 and box 5.  An alternative would be when entering this Form 1099-R into TurboTax you enter into box 5 of TurboTax's 1099-R form the same amount as is in box 1.  Because there is no tax withholding on this form, the details of the form will not be included in your e-filing.  The entry in box 5 serves only to tell TurboTax the amount to add to contribution basis on its IRA Information Worksheet.  Still, I think it's preferable to not alter Form 1099-R values since there is another method that produces the correct result.

Hopefully you won't need to withdraw amounts from your Roth IRA before the Roth IRA 5-year qualification period has been completed, in which case your basis in the Roth IRA wouldn't matter.  Roth distributions used for obtaining spending money deplete funds that otherwise have the potential to enjoy tax-free growth.

"fact my Roth 401K is qualified does not seem to matter."

It does not matter with respect to how this distribution from the Roth 401(k) and its rollover to the Roth IRA is taxed.  Such a rollover is nontaxable whether or not it's qualified.

"Fidelity also says the rollover cannot be considered a contribution to the Roth IRA as if it was, then contribution limits would apply."

Fidelity seems to be saying that it's not an ordinary contribution.  It is indeed a rollover contribution and will be reported as such in box 2 of the Form 5498 for this Roth IRA.

[Opus 17]

@Aussie 

I will point out that the adjustments @dmertz  is talking about to the Roth basis refers only to Turbotax's optional tracking of IRA basis.  It does not get reported on any tax form.  If you withdraw amounts in less than 5 years, it is up to you to self-certify that the amounts are considered "contributions" or "earnings" (and it is up to you to prove it if audited).  Turbotax offers the ability to track your Roth basis and perform that calculation for you, but if you can track your basis separately, you don't have to use turbotax to track your basis.  And if you make a withdrawal in less than 5 years and Turbotax thinks it is taxable because Turbotax has the wrong basis number, you can correct that when you need to.  

[Aussie]

Thank you, good to know additional information!